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Best Latin America ETFs for 2013 (Part I): Mexico

Latin America’s largest economy Brazil is currently growing at one of its slowest rates in a decade of about 1%--despite significant measures taken by the authorities to stimulate the ailing economy.

On the other hand, some other countries in the region like Mexico, Colombia, Chile and Peru continue to put in impressive economic performance. In Part I of this article, we have analyzed Latin America’s second largest economy--Mexico, which may overtake Brazil in the coming years, according to some economists. (Read: Escape the Cliff with These Dividend ETFs)

Economy on sound footing; Fiscal consolidation on track

While Brazil benefitted immensely from the commodity boom of the last decade, it used its regional superpower status to promote domestic companies. On the other hand, Mexico adopted open market policies, fiscal discipline, labor reforms and prudent macroeconomic measures. As a result, the economy is on a sound footing--currently growing at about 3.2%.

Things look good on the fiscal front as well, with a budget deficit of just 2.5% of GDP compared with 8.6% of GDP for the US, for 2011. Gross debt stands at about 43% of GDP, compared with more than 107% for the US, per IMF. (Read: Buy These Emerging Asia ETFs to Beat China, India)

While credit as a percentage of GDP has doubled in Brazil to about 50% in last ten years and the credit boom seems to be finally coming to an end; in Mexico, it is around 20%, indicating significant room for expansion.

International investors, led by PIMCO, now own 53% of Mexico’s $144 billion fixed-rate peso bond market. As a result, the bond market yields hit all-time low this year.

Bank of Mexico has kept the key rate unchanged at 4.5% since 2009 as the inflation has generally remained within its target range of 2% to 4%. Central bank expects the inflation to come down to 4% by the end of the year from 4.2% currently. Country’s foreign reserves have risen to $165.4 billion as of the end of August 2012.

Though the currency has recently been hit by US fiscal-cliff concerns, it is still up 7.8% year-to-date. Additionally the longer-term outlook for the Peso looks promising, given the country’s macroeconomic position, rising exports and comfortable foreign exchange reserves position.

New China of manufacturing?

China’s average manufacturing wages, when adjusted for productivity, are above those in Mexico now, according to a study conducted by the Boston Consulting Group (BCG). BCG forecasts that by 2015, the fully loaded cost of hiring Chinese workers will be 25% higher than the cost of hiring Mexican workers.

Further, Mexico’s proximity to the US means that the companies can ship the goods to the customers much faster and at a much lower cost—as the price of oil has gone up three times since the start of the century. Moreover, the goods coming from Mexico can enter the US duty-free due to NAFTA.

Mexico also has an edge over China in the demographics area. While China’s population is beginning to age (median age-33.2 years), Mexico has a largely young population (median age-26.0 years). The difference will worsen in coming years due to China’s one-child policy.

As a result, many US manufacturers are now shifting production to Mexico from China. Last year, Mexico’s manufactured exports were more than the rest of Latin America combined. Based on current trends, it is estimated that by 2018 America will import more from Mexico than from any other country.

More reforms on the way

Enrique Pena Nieto, who assumed President’s office last week, has pledged more reforms in the energy sector—allowing more private investments and encouraging development of shale gas reserves; and tax reforms to bolster tax revenues.

According to the new administration, the reforms could accelerate the growth to 6%. While many details of the proposed reforms remain to be seen, the new President has clearly indicated his willingness to bring about far-reaching changes.

Risks

The country suffers from a high crime rate, drug-related violence and income inequality. About 46% of Mexico’s population lives in poverty.

Further, the economy is still very much dependent on the US as a consumer of about 80% of its exports. Any contraction in the US economy in case goes over the fiscal cliff will affect Mexico.

On the domestic front, the country needs to increase tax revenues and decrease dependence on oil income.

EWW tracks the MSCI Mexico Investable Market index which consists of stocks traded primarily on the Mexican Stock Exchange. The index is a capitalization weighted index that aims to capture 99% of the total market capitalization.

Launched in March 1996, the fund now has more than $1.7 billion in AUM. The assets are invested in 46 holdings with an average market cap of $30 billion. Consumer Staples (31%), Telecom (21%) and Materials (19%) are the top sectors that the fund is invested in.

Growing consumer demand in the country suggests that the fund will benefit from its heavy exposure to consumer staples and telecom sectors.

The fund charges 52 basis points per year in expenses and currently has a 30-say SEC yield of 1.33%. The ETF has gone up 31% year-to-date.

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